Good Sense on Fiscal Policy

I commend Greg Mankiw's op-ed in today's Wall Street Journal. Even a generous set of excerpts will leave out a lot of well-phrased analysis.

let's start with a fact about which every serious policy analyst agrees: The government budget is on an unsustainable path...The promises made to my generation for Social Security, Medicare and Medicaid are just not affordable, given the projected path of tax revenue.

...Some supply-siders like to claim that the distortionary effect of taxes is so large that increasing tax rates reduces tax revenue. Like most economists, I don't find that conclusion credible...Yet the supply-siders are right about one thing: Because higher tax rates reduce the size of the tax base, raising taxes generates less revenue that the "static" revenue estimates assumed in Washington would suggest.

...Many economists, including myself, would recommend that the nation consider a gradual but substantial increase in the age at which people become eligible for taxpayer-financed benefits for the elderly, including both Social Security and Medicare...If we raise the age of eligibility for retirement benefits, people could still retire early, but they would do so on their own nickel, rather than the taxpayer's.

...Although the fiscal gap could be completely closed with reduced spending, a realistic political compromise will likely include higher revenues as well. Even here, however, rather than consider a reversal of the Bush tax cuts, the new Treasury secretary should look for more efficient revenue sources.

...A higher tax on gasoline, for example, is better than CAFE standards as a policy to improve the fuel efficiency of the American car fleet. It would also encourage people to drive less by, for instance, living closer to where they work. A tax on carbon is the best way to deal with global warming.

...even if the income tax is to be used to increase revenue, we should broaden the base rather than raise rates.

Mankiw served as the Chairman of the Council of Economic Advisers in 2003-2005. I do not see the policies of the Bush Administration in that period as reflecting the views in Mankiw's op-ed. One has to believe either that (a) Mankiw's views in the op-ed differ from those he expressed as an advisor or (b) he expressed similar views as an advisor, but those views were not embraced by the Administration. I would put a large wager on (b).

If I look back over the last thirty years or so, I think that professional economists, like Mankiw, have given good advice. On average, I think that Democratic Presidents have come closer to taking advice, especially advice that might otherwise have been unwelcome.

I am not saying that Carter and Clinton were grade-A economic policymakers, but they left the country with somewhat better policies than they inherited. I think that they differed more on luck than on skill, and if you average the economic statistics of their two Presidencies you get a good indicator of their performance.

I don't think of Ronald Reagan as someone who listened to academic economists. But he had a hearfelt commitment to markets and individual choice, and that served him fairly well. In terms of the makeup of Congress, Reagan had a less powerful political hand than George W. Bush, but he played that hand much better.

So far, I feel that President Bush has neither a passionate commitment to individual choice nor a willingness to listen to the best advice that the economists have to offer.

Arnold Kling:
If I look back over the last thirty years or so, I think that professional economists, like Mankiw, have given good advice. On average, I think that Democratic Presidents have come closer to taking advice, especially advice that might otherw [Tracked on May 31, 2006 3:48 PM]

"I don't think of Ronald Reagan as someone who listened to academic economists."

Why do you think that, Arnold? I'm really not qualified to challenge your opinion on Reagan's economics. I just want to better understand your thoughts.

Wasn't Reagan listening to economists when he reduced marginal tax rates? or when he eliminated price controls on oil, cable TV, and telephone service?

Certainly the Reagan administration was wrong to place quotas on steel and automobiles. I think those were political decisions offered as concessions to an unyielding Congress. Overall, though, didn't Reagan support free trade? I remember he proposed a NAFTA-like policy in 1980, and by 1988 had won approval of U.S.-Canada free trade. Didn't his administration back creation of the World Trade Organization and the successful Uraguay trade negotiations? resulting in lower global tariffs?

I'll admit I'm biased about Ronald Reagan. His photo on my desk is larger than those of my wife and my beagle. But I pledge to remain objective if you have time to provide more insights.

Reagan did have a "hearfelt commitment to markets and individual choice" which guided his policy choices, even when there was little he could do to sway Congress. Nicely put, Arnold.

But I hope to correct your characterization of him on this score:

I don't think of Ronald Reagan as someone who listened to academic economists.

One of my most respectful memories of President Reagan when I worked for him on the Council of Economic Advisers was how very carefully he did listen to academic economists.

The evidence for this abounds. During his presidency, the Chairman of the Council was a cabinet position. Academic economists filled positions previously held by bureacrats, and were even hired by the State Department's small economic analysis division (disbanded after Reagan left office).

Perhaps the most striking evidence is the moral of the trouble Reagan got into when he enthusiastically listened to the academic economists around him. In the first Mondale/Reagan debate in 1984, Reagan relied on Barro's newly revived Ricardian equivalence theorem to state with conviction:

The connection that's been made again between the deficit and the interest rates - there is no connection between them. (transcript)

The flabbergasted Mondale--and the press in the next few days--scoffed with derision and treated it as evidence of Reagan's naivete. In fact, it was Reagan who was excited by and understood the academic discussions of Ricardian equivalence well enough to see their implications. Neither Mondale nor the press had a clue.

JD and Lauren,
I don't get the sense that Murray Weidenbaum and Martin Feldstein had happy experiences at the CEA.

As for the Barro anecdote, suppose Barro had put it, "Mr. President, what Ricardian equivalence says is that when you cut taxes people save the money, because they know you're just going to have to raise taxes again later to pay for the deficits."

I'm not sure Reagan would have been quite so enthusiastic about quoting Barro in that case.

Why do you believe that Carter left the country better policies than he inherited? Was it his lovely price controls on gasoline? His tax policy? His spending? America was in the worst shape of many decades when Reagan ran for office - that is why he won, unknown as he was.

As for Clinton, it was the republican congress that pushed many of the good reform policies, such as welfare reform. He also had the benefit of looking good during a bubble, leaving Bush with the inevitable bust. He also had the luck of technology, much of which was invented during Reagan's presidency; and the Wal-Mart cost-cutting boom (eg see American Enterprise this week for discussion of Wal-Mart's economic impact during the 1990s).

Do you really think that cutting taxes can never increase revenue? I have seen several studies that suggest that in quite a few cases it has. I have read studies regarding tax cuts in Eruope and the US where revenue did increase after lage tax cuts. Didn't revenues increase in the 1920s, under JFK and under Reagan after tax cuts? (e.g. http://www.heritage.org/Research/Taxes/wm327.cfm)

There is certainly a level of taxation that depresses growth enough that revenue drops. My own agent based analysis suggests that a 15% flat tax (combined with a 15% ELR program) brings in the most revenue (although an even lower rate increases prosperity even more). At 20% of each, the revenue drops and at 30% it drops much more than that. In another model that does not combine the tax with the ELR program, the government uses a learning algorithm to find the revenue-maximizing tax rate; it does not keep raising the tax rate because it often leads to lower revenue. You can view the results of the first model mentioned here:
http://www.economicliberty.net/cgi-bin/agent_submit.cgi

I can't speak for Weidenbaum or Feldstein (nor for Mankiw, Hubbard, Boskin, or any CEA Chairman), but neither Weidenbaum's nor Feldstein's complaints were that Reagan wasn't listening to them.

When policy-makers and government-hired academics don't get along because the bureaucrats don't want to hear what the academics have to say, the bureaucrats always win the battle. They win by attrition because the academics have better things to do with their time than devote themselves to the ins and outs of internal politicking and government jobs. The better the academic, the higher that opportunity cost.

Feldstein's historically-documented disagreements were certainly not with Reagan (nor with the CEA) but with other policy officials. [Background link here.] Feldstein's academically-based credibility was supported and valued by Reagan.

On another note:

...when you cut taxes people save the money, because they know you're just going to have to raise taxes again later to pay for the deficits.... I'm not sure Reagan would have been quite so enthusiastic about quoting Barro in that case.

Actually, I'm sure Reagan understood, loud and clear, that exact point behind how Ricardian equivalence works. Increasing private saving was right up his alley.

While the conditions necessary for Ricardian equivalence to hold were not details Reagan probably had time or inclination to consider, the basic principles were as clear to him as they were to Ricardo when Ricardo alluded to them offhandedly 200 years ago, knowing that his readership already understood.

Ricardian equivalence isn't rocket science. What is rocket science is modelling why the recommendations of academic economists are too often cast away, muted, or lost in the political fray by the very presidents who hire the academic advisers for their scientific objectivity.

Arnold, do you really believe this part: A higher tax on gasoline, for example, is better than CAFE standards as a policy to improve the fuel efficiency...? The rest sounds pretty good, but why not let prices dictate fuel efficiency? Why shoot ourselves in the foot with higher gas taxes? What's the point of greater fuel efficiency anyway?

True, he was lucky to be president when high tech exploded and when huge Boomer social security surpluses masked true government deficits. But the bottom line for me is that he didn't screw it up. And this is coming from a conservative Republican who finds Bill Clinton to be morally disgusting.

I would favor a small increase in the gasoline tax - not to promote fuel efficiency but to increase highway funds. The gasoline tax is a user fee that has neither kept pace with inflation nor been adjusted for increased auto efficiency. I think it was last raised in 1993.

In my state we have "road bonds" to pay for the highways; in other states they use tolls at least in part. Why use a federal gas tax, or even a state gas tax instead? As far as I know, that money doesn't actually make it to the highways very often. In addition, the reasons the roads are so expensive is in large part because of the unions and because of a lot of unnecessary work that is done to keep the unions happy and to keep the states happy (to receive federal money that does make it their way so long as they keep hiring more union workers - which in turn they may not spend on the projects, if they can use :road bonds" instead). Its the definition of pork barrel spending.

In my state we have constant construction on roads that are already 3 lanes, in good condition and previously "beautified." They tend to take between 6 months and 2 years for every project and it just creates traffic jams, as far as I can tell. Every once in a while you can see what happens when a private contractor does the work - hired by Wal-Mart for example, then it takes 3 weeks instead. Every ballot has at least 3 highway and road bond initiatives despite the federal and state gas taxes.

So, I don't really sympathise with your call for higher taxes for that reason.

The reason that highway bonds and toll roads have emerged as sources of financing is precisely because the gasoline excise tax is too low. Here's an explanation:

http://tinyurl.com/frley

You may believe that construction and maintenance of our transportation infrastructure has been adequate the past two decades. I doubt that many commuters will agree with you. I've lived and worked in six large cities since 1980. In every one, citizens have loudly and consistently complained that existing highways are inadequate to meet commuter traffic.

"Every once in a while you can see what happens when a private contractor does the work "

As far as I am aware, all public highway construction is performed by private contractors.

You are referring to private funding of highways when you mention Wal-Mart hiring contractors. I've never read anything about Wal-Mart building a public highway. Where did that happen?

Stan Collender suggested we send you a link to an easy-to-read pamphlet titled, "The Financial State of the Union." This eight-page document summarizes the financial condition of the federal government.

This pamphlet is published by the Institute for Truth in Accounting. The Institute for Truth in Accounting is made up of business, academic, governmental and other leaders who are committed to high standards of ethics and integrity and who support these principles in the private as well as in the public sector. The IFTA’s mission is to enhance the credibility of public and private sector financial reporting by encouraging the issuance of understandable, reliable information.

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